Real Estate in Dubai offers healthier Return on Investment

The real estate market in Dubai offers an average yield of 7 per cent, about 2-3 per cent above the average yield in international property markets, especially when compared to the modest yields that mature markets like London, Paris or New York offer.

Traditionally, investors have been attracted by the possibility of high returns from properties in Dubai, in addition to the absence of property tax unlike in other parts of the world.

Although of late there has been a slowdown in sales of luxury residential units across the emirate, the constant rise of the expatriate workforce has essentially meant that more people are now looking for rented apartments to live in. Rental yields from the affordable housing segment in Dubai – where multiple projects were launched during the first half of 2015 – remain higher than the average yield.

The average yields at which we have seen transactions happening in the Dubai real estate sector during the first half of 2015 is between 7 to 8.5 per cent. Analysing the two components of return on investment (RoI), i.e. yields and capital appreciation, over a long term period, we observe the yields to be in the range of 6 to 9 per cent per annum and average capital appreciation in the range of 10 to 20 per cent per annum, making the effective RoI in the range of 15 to 30 per cent per annum.

However, given the highly dynamic nature of the Dubai market and the fact that it is largely a sentiment-driven one, depending upon an investor’s exact timing of entry and exit from a property, his/her specific RoI could be significantly higher or lower than the average RoI.

Rentals stable in Q1 2015

The first quarter of the year continued to see subdued activity in Dubai’s real estate market. While residential rents remained relatively flat, sale prices saw a marginal decline across both apartments and villas.

The first quarter of the year saw the delivery of approximately 730 residential units across Dubai. An additional 22,000 are expected to enter the market by the end of 2015.

This downward trend is expected to continue throughout 2015, as we foresee prices dropping up to 10 per cent by year-end.

Sales index issued by a Dubai-based Real Estate Investment and Development Information Network (Reidin) depicts a marginal decline in prices across both apartments and villas. This comes as the Reidin rental index shows growth levels dropping to 8 per cent Y-o-Y in February 2015 (from 23 per cent Y-o-Y in Q1 2014). Similarly, the Reidin sale price index shows a decline in growth levels from 30 per cent to 6 per cent over the same period.

According to the first quarter of 2015 figures, Dubai Marina and Jumeirah Beach Residences (JBR) recorded a total transaction value of Dh1.08 billion, spread across 512 deals, which equates to an average deal value of Dh2.11 million. During the same period Emirates Living recorded total sales of Dh808 million, from 245 transactions.

The residential leasing market has remained broadly stable for a third consecutive quarter, with only minor changes in rental rates recorded. The market’s relative stability during the past nine months is reflected in the huge swing in growth figures from 27 per cent in the year to Q1 2014 versus 3 per cent in the year to Q1 2015.

With residential sales prices expected to decline faster than rents in the coming months,we may start to see yields move out as we progress through the year.

Commercial Property

Dubai’s office market remained relatively stable over the first quarter, with average rents across the Central Business District (CBD) recording Dh1,880 per square metre and vacancies registering 23 per cent.

Demand for Grade A quality stock continues to be robust, particularly in the Dubai International Financial Centre (DIFC) and its surrounding precinct, evident by the rate of leasing activity.

In turn, demand for Grade B office space remains weak, exerting downward pressure on asking rents. The first quarter saw the handover of Central Park in DIFC, adding approximately 130,000 square metre of office space to the market. This brings the total Gross Leasable Area (GLA) to 7.7 million square metres as of Q1 2015.

Office sales transactions in Q1 remained relatively limited with Business Bay and Jumeirah Lake Towers being the most transacted areas; these areas rose by 2 per cent and 5 per cent respectively. Tecom saw the largest year-on-year increase of 14 per cent. DIFC supposedly offers rental yields of 6.75 per cent for prime offices.

For commercial investments by institutions or large individual investors, transactions have slowed due to wide bid-ask spreads.

Owners are holding out for yields that are less attractive to investors now. In other words, yields based on asking prices are difficult to justify when compared with other markets. In the commercial market asset-specific issues augment these gaps. For example, in office building, tenancy is often dominated by one year renewable contracts. This increases the risk profile of the asset.

Another common issue is poor asset maintenance, which accelerates depreciation. We’ve seen many owners opting for inexpensive properties.

Optimistic industry players believe Dubai has seen expansion in several major sectors, particularly finance, pharmaceutical and technology, and such an expansion creates jobs and stimulates demand for office space.The quality office average yields in Dubai will be between 6 and 7.5 per cent.

This year will see a very mild softening due to largely external factors such as the appreciating US dollar. We foresee increase in prices and rents in prime office areas, such as Downtown, DIFC that generally see very high level of occupancy and strong resilient demand for quality office space.

Return on Investment

The overall growth of the Dubai market, supported by factors such as security, a tax-free haven and a safe investment structure, makes realtors assure lucrative returns. Moreover, Dubai emerging as a more mature market for real estate post the 2008 recession, has garnered investors’ confidence.

The developers often price units at rates that would achieve profits higher than their targeted returns. This enables them to offer rebates in the form of guaranteed returns to buyers for a limited number of years.

The return on a property generally depends on its location, surrounding infrastructure, quality of construction and of course the developer’s repute. However, in certain cases developers/brokers promise ambitious yields based on their knowledge of the market, which at times can be lower than the average market RoI rate.

Experts advise buyers not to fall for the illusion of investing in a high-return property and make informed decisions. In Dubai, the guaranteed ROI concept is more often than not a ‘marketing gimmick’. Once you go through their detailed terms and conditions, you will find so many caveats in their guaranteed return claims that covers them up in the event of actual returns from these properties being lesser than what they were supposedly guaranteeing at the time of sale of the property.

It is not uncommon for some developers to factor in a guaranteed yield in the sale price, which can create an illusion for buyers. There is a double loss here for the buyer.

Firstly, he will overpay for the property as the subsidised guaranteed rent has been factored in by the developer and added to the price. Secondly, when the guaranteed period is over, very often the owner will find out that market rents are not anywhere close to the subsided rent he was getting during the guaranteed period, and he will have to readjust the asking rent in order to get the property leased (with of course a negative impact on the property price should he decide to exit).

Initial yields are an important instrument when acquiring real estate, but investors should also follow a holistic approach to their investment, not stopping their analysis at the first few years return (guaranteed or not). There are several other basic tools like NPV [Net Present Value], IRR /modified IRR [Internal Rate of Return] that should always complete the picture.

Realtors mostly guarantee returns on ‘hospitality related assets’, such as hotel apartments, as they compute RoI assuming returns based on current room rates and occupancy levels. However,the returns can sometime be lower than these estimates, as the current room rates vary based on the location and rating of the project/ asset, while a new hotel/asset may not be able to achieve the same rate/occupancy levels.

The prices of many of these assets are on the higher side to offset lower room rates or occupancy levels. And that means a buyer is buying at higher then market price. We urge buyers to do their due diligence when purchasing assets with guaranteed returns.

Better yields

Developers have been launching projects in Dubai since the start of the year. Major builders, the likes of Emaar, Nakheel, Dubai Properties and wasl, are focussing equally on the old areas of the city by launching redevelopment ventures, along with building projects in prime locations. Major project announcements in old areas like Dubai Creek, Deira, Naif, Ras Al Khor and Karama have created ripples in the market.

Prime locations in Dubai, such as the Downtown, DIFC, Business Bay and Dubai Marina have shown signs of maturity and have witnessed fewer project launches. Developments in these prime locations now mostly comprise single buildings. However it is the upcoming areas, with good availability of land, where developers are rushing to launch projects. Places like DWC, DIP, Sports City, Motor City, International Media Production Zone (IMPZ) and Mohammed Bin Rashid City have attracted the attention of investors and end-users alike, mostly due to the fact that returns from properties in such locations would be handsome. The Springs community is reportedly proving to be a high-yielding investment as rentals have gone up by up to 10 per cent, while prices have gone down by 25 per cent on an average, in the last 12 months.

Upcoming areas such as Sports City and Dubai Silicon Oasis offer highest yields from 13 per cent upwards. Although less desirable lifestyle options, these properties rent quickly and most landlords bought off plan and are reaping the benefits now.

Rental rates, on average, remained unchanged in Q1 2015. However, certain adjustments, either upwards or downwards, were witnessed across select areas, with less desirable properties lowering their asking rates to attract tenants.

Some increases were witnessed in newer communities, such as Jumeriah Village (+4 per cent year-on-year) and Dubai Sports City, as these are better established and vacancy levels are low. The highest year-year-on-year apartment rental increases were found in Palm Jumeirah (+16 per cent).

Luxury Vs Affordable

The high demand for budget housing in Dubai has led both existing and new developers to plunge into this segment.

Multiple affordable housing projects were launched in H1 2015 in various locations of the emirate. Although end-users are apparently the highest buyers of budget properties, investors too have begun cashing in on this segment, as such units come at low prices but promise great returns. The RoI for a developer is higher on luxury properties just due to the fact that the higher selling price of the unit.

Affordable developments, such as International City and Discovery Gardens, offer high RoI, as these two communities are among the few recognised locations offering budget housing and have been addressing the gap for low-cost housing in Dubai for a number of years.

The yields are higher in case of an affordable property, but the capital appreciation can be higher in case of luxury properties, provided entry and exit are made at the right time.However, the downside risk in case of affordable properties in good locations is much lower than that of luxury properties. Accordingly, if the investor considers RoI in conjuction with the risk reward ratio, affordable properties in good locations will be better off compared to luxury properties.

Affordable housing projects have enabled the mid-segment in Dubai to now own properties, rather than live on rent. Thus as property-owners in Dubai grow, there is a chance that the number of renters will shrink. So ‘will people buying more going to impact rental yields?’ is a question that an investor would probably ask.

Not really. As much as Dubai builds more housing to accommodate the growth hundreds of thousands of expatriates arrive and still chose to live in Prime areas such as The Marina and Downtown for both lifestyle and comment.

As long as Dubai’s population keeps growing at a rapid pace and the demand-supply equilibrium for rental properties is maintained, the yields may still be maintained at the current levels, as the rental demand reduced due to some of the residents buying these affordable housing properties would be substituted by rental demand from these new residents moving into Dubai.

The key to maintain the rental yields at their current levels is the continuous growth of Dubai’s population through creation of more business and employment opportunities.

Global markets

Dubai fares incredibly well in terms of average yields compared to more traditional international markets such as London. In prime central London one would be expecting to see returns of maximum 4 per cent. However in the prime property sector in Dubai, one could expect returns between 5 to 8 per cent on villas and 8 to 11 per cent on apartments.

Although the Dubai real estate market has been maturing over the past few years, it is still very much an emerging market in many regards. The risk factor plays an important role in determining yields, and investors looking at much deeper markets such as London, New York or Paris will continue to accept lower yields compared to Dubai for years to come.

In Dubai, property yields for individual residential units are often higher than in markets like London or New York. However, the yields should be higher in Dubai because it has a higher risk profile. Volatility is commonly used as a measure of risk and Dubai is a highly volatile market. Markets like London and New York have a long, stable track record and are located in developed countries with low risk profiles backed by legal systems that balance investor and tenant rights. Generally, there is a positive correlation between yields and risk – higher risk should generate higher yields.

One of the key reasons why Dubai offers high RoI on property is because of its tax-free characteristic, which puts it at a significant advantage when compared to a market like Mumbai.

However, as Dubai continues to become a global hub, yields however will be compressed. Moreover, rental yields in Dubai have come under pressure consistently over the last few years. While it was common to achieve up to 10 per cent depending on the asset class about seven years ago, investors quickly recognised the value and relative stability of this market which pushed property yields to the 7 per cent level by 2013. Since 2014, yields have ceased their descent and have remained stable at 7 per cent owing to cautious investor sentiment.

Following two years of strong growth for Dubai’s residential sales, 2014 was a year of stabilisation with moderate growth during the first half of the year followed by a decline in H2. The slowdown in activity for the second half of the year can be attributed to the delivery of new supply and the impact of low global oil prices on key source markets such as CIS and GCC countries.

As an emerging market, Dubai is affected by macroeconomic changes in other parts of the world and investors’ behaviour is reflective of this influence. Global stability and global growth are both important for Dubai, which market itself as a global hub.

Exogenous shocks like the fall of the Russian Ruble and the difficulties faced by the Russian economy had and will continue to have a certain impact on the Dubai economy. Instability in the Eurozone, and sustainability of China’s GDP growth are also potential threats to the global economy, and hence the Dubai real estate market.

On another note, as the Indian real estate market develops and continues to offer quality properties, Non-Resident Indians (NRIs), who are the largest buyers of property in Dubai, are now getting lured by the similar properties back home.

Paradoxically, sustained low oil prices, which typically support growth in most parts of the world could also have a long term negative impact on Dubai because of the regional instability it may trigger, and the high mid-term dependence of Abu Dhabi on higher oil prices.

As long as the rest of the world steadily grows, global and regional corporate investors in Dubai support prices and rents on the office market, create jobs which translate into renters on the residential market, supporting prices and rents there too, and creating demand for retailers, and retail space.

Against a backdrop of low interest rates globally and relatively volatile financial markets regionally, the flow of capital into real estate has continued. Demand for institutional quality assets across Dubai and other key GCC centres has been rising, assisted by numerous factors, including the fact that yields remain relatively high in context of other global cities.

Local factors most importantly dictate market dynamics. The UAE-wide Federal Mortgage Cap and Dubai’s doubling of Property Registration Fees last year have together gradually and successfully contained the market, with a decrease in speculative activity from investors.

The upward creep of project completions, coupled with the slow motion impact of new real estate regulations and the general dent to sentiment as a result of the slowing rate of house price growth, in a sentiment-driven market has weighed heavily on the emirates residential market, with the 2015 outlook remaining somewhat mute, with villas expected to bear the brunt of price declines.

Despite investors still remaining as the dominant force in the Dubai real estate market, end-users today also have significant sway over the market’s movements. A buyer today makes a much cautious and informed property purchase decision, than the pre-recession times.